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Ask an Expert: Dr. James “Cid” Seidelman on Brexit

Dr. Cid Seidelman on Brexit

On June 23, 2016, 52 percent of Britain voted to leave the European Union, which caused uncertainty and shock throughout the world. Britain’s prime minister, David Cameron, stepped down; US and global markets were immediately impacted; and the value of the pound plummeted to the lowest it has been since 1985. Dr. James “Cid” Seidelman, Distinguished Service Professor and professor of economics, explains the possible economic outcomes of Brexit and why it has such an impact on the local economy.

by Lily Wolfe (’18)


What does Britain leaving the European Union (EU) really mean, and does the passage of the Brexit referendum mean that Britain definitely will leave the EU?

The Brexit referendum has set the stage for the UK to possibly leave the EU. The EU is an economic and political federation consisting of 28 member countries that make common policy and adhere to the rule of four freedoms: free movement of labor, capital, goods, and services across all borders of the union. The EU was created in 1993 to economically integrate a single market economy of European countries, along with 440 million consumers. Since the end of WWII, there have been significant efforts to integrate the economies of Europe and to end nationalist tendencies that led to the carnage of two world wars.

Separating from the EU legally only occurs if Britain triggers Article 50 of the EU’s Lisbon Treaty, which then begins a two-year exit process to renegotiate trade, labor and capital mobility between Britain and the remaining 27-nation EU bloc. Separated from the EU, Britain would need to negotiate new terms related to the four freedoms of the EU and new bilateral agreements with the rest of the world in its new role outside the EU.

Could Brexit be a catastrophe that never happens? In this best-case scenario, Article 50 is never triggered and Britain stays in the EU. What causes this inaction? First, Scotland, Northern Ireland, and the financial center of London have all reacted negatively to Brexit. Their political and economic clout should not be underestimated. Second, negotiating the terms of the divorce will take time. More Brexit remorse will develop as people become aware of the negative economic consequences of succession and the unlikelihood that the EU and its remaining countries are going to negotiate terms charitable to the UK. Third, Brexit remorse is shared on both sides of the English Channel. The EU itself may engage in reforms to reduce its bureaucratic reach and the opacity that has been its trademark since its formation. Recognizing what has already happened in the UK, the EU may choose to stem populist pressures in their own countries by implementing some of these proposed reforms.

What are the likely long-term effects on the economies in Europe, Britain, and the world in response to Britain leaving the EU? 

If Britain leaves the EU we can expect greater uncertainty and a further drag on global economic growth. Even with further monetary easing by the Bank of England, Britain itself would almost certainly go into recession. Economic models predict a UK exit would reduce British GDP by 2.2–9.5 percent—or anything from a moderate slowdown to a deep recession. If Britain is able to negotiate continued access to EU markets, the decrease in their GDP will be smaller. If not, British exports to the EU will fall and the more pessimistic scenario is likely to prevail. A drop in British exports will weaken the pound, making British exports cheaper and mitigating some of the fall in trade with Europe. But any reduction in British exports will reduce their GDP.

Prospects for the EU are less dire, but the weakness of other EU economies suggests that growing uncertainty could also derail their growth. Much of the remaining world should experience only negligible impacts on growth. However, the International Monetary Fund recently issued one of its most dire forecasts to date, calling the impact of Britain’s departure from the EU “negative and substantial.”

What does the adoption of Brexit mean for global trade? Will Britain have to make all new trading agreements? 

For Britain, the overall trade effects of Brexit are complicated by the nature of the exit negotiations with the EU. Three possible scenarios regarding the future of UK trade are possible. The first is an outcome promoted by pro-Brexit supporters who argue that by withdrawing from the union, the UK liberates itself from EU policies and regulations and that this new independence provides expanded trading opportunities with the rest of the world, including the faster growing markets of China, India, and Brazil.

An alternative view promoted by proponents of “stay,” argue that withdrawal from the EU will significantly reduce access to European markets—currently Britain’s most important trading partners. Further, gains in other markets will be limited by the fact that much of the rest of the world has multilateral trade agreements with the EU—with the UK as a member, not as an independent. So yes, Britain will have to develop new trading agreements with the EU and the rest of the world, a process that could take years. This pervasive uncertainty will impact decisions about future business investment and protracted negotiations could leave them hanging on a limb, dampening demand and undermining worldwide economic growth.

Reality will most likely fall somewhere between these two extreme scenarios. But any reductions in the volume of British trade will negatively impact their economy. As noted above, much can still transpire and the final outcomes will depend on how well the UK can negotiate continued access to European and other world markets.

What are the economic impacts of Brexit on the US? 

Imports and exports to the UK account for less than 5 percent of America’s total trade in goods and services. However, there is more than a trillion dollars of investment and trade between the US and the UK. The US is the single largest investor in Britain and more than a million Brits are employed by American companies. Continued access to British and other European markets is absolutely critical to the US economy. There is also already talk about moving the world’s financial capital from London to the Continent and that has significant implications for many US companies and financial institutions regarding their current operations in the UK.

From a trade perspective, Brexit has weakened the pound and strengthened the dollar, making British exports to the US more competitive. But the volume of trade between the two countries suggests only a slight impact on the US economy.

Growing uncertainty also leads to British and other foreign investors fleeing the risks associated with Brexit and seeking a safe haven by purchasing dollar-denominated financial assets, such as US Treasury securities. This puts upward pressure on the value of the dollar and makes US exports less competitive. Again, this increases the headwinds facing the US economy and has the potential to slow US economic growth.

Finally, all the uncertainty created by the referendum and the possibility of Britain actually leaving the EU will influence the Federal Reserve’s plans for ongoing interest rate hikes. The interest rate environment has already gotten friendlier as mortgage rates and other long-term borrowing costs have dropped. These lower long-term rates, along with greater Fed caution in raising short-term rates will help to counter the hit the US economy takes on trade.

 

 


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